Consider a retail gasoline market. Assume the following throughout your analysis: (i) a retailer’s variable cost of supplying a gallon of gas is $0.10 plus the wholesale price of the gallon; (ii) retailers’ contracts with wholesalers fix the retail price at $0.25 per gallon above the wholesale price; (iii) annual fixed costs for a retailer equal $50,000; (iv) all wholesalers charge the same wholesale price; (v) all gas stations in the market have equal market share; (vi) gas station owner/managers keep all station profits for themselves; (vii) entry and exit are free, but all gas station owner/managers could earn $100,000 annually in some other job. Required:
a. Let Q be the equilibrium amount of gasoline sold in this market in number of gallons, and let N be the equilibrium number of gas stations. What is the mathematical relationship between N and Q? This should be expressed as N = something something Q or Q = something something N.
b. Suppose a temporary supply shock, e. g., a hurricane, causes an increase in crude oil prices, thereby increasing wholesale gas prices. Assuming temporary means the short run, what is the impact of the oil price increase on retail gas prices? Show this on a graph. What information would you need to determine the exact effect of this short-run change on the quantity of gas sold and gas station profits?
c. What is a shock that would have the same effect on supply but that would make it look more like a permanent change? Assume such a shock happened. Show on your graph what would happen to the demand curve for gasoline. Why would this happen?
d. How would this permanent change affect the number of gas stations in the market? Why?